Are the Sino-U.S. Trade Frictions Truly Escalating?

The initial Chinese response - and the effects - may not be as severe as many fear. But for the U.S., it's a different story.

Hours after President Trump instructed U.S. Trade Representative Robert Lighthizer to slap tariffs on at least $60 billion in Chinese imports, China's Commerce Ministry reacted.

In response to the U.S. threat, the Ministry announced plans for reciprocal tariffs on $3 billion of imports from the United States - including a 25 percent tariff on U.S. pork and recycled aluminum, and 15 percent tariffs on American steel pipes, fruit, and wine. Thus, in the past two weeks, Sino-US trade friction escalated, and a "trade war" was possibly imminent.

So, just why did the Trump administration start the trade dispute?

The official reason is that China violates U.S. intellectual property, under the Section 301 of the 1974 Trade Act. In early 2017, after Trump took office, he threatened to define China as a currency manipulator and talked about imposing up to 45 percent tariffs on targeted Chinese products.

Then, in the summer of 2017, he accused China of stealing American intellectual property rights and launched a seven-month "301" investigation by the U.S. trade representative's office into allegations that China engages in a range of violations, including accessing of trade secrets through hacking and setting policies that force American companies to transfer technology.

"We have a tremendous intellectual-property theft situation going on" with China affecting hundreds of billions of dollars in trade each year, Trump said.

By this logic, the direct result is the widening trade deficit. In 2016, the U.S. trade deficit with China amounted to $347 billion, accounting for 44 percent of its total deficit. And from the Trump administration's view, the tremendous bilateral trade deficit is mainly due to China adopting a policy of export tax rebates and subsidies, intellectual property theft, and price-based dumping on the American market. As a result, the US hopes to reduce the trade deficit by imposing high tariffs on China.

Is This Trade Action Likely?

We doubt it. Firstly, the targeted products that would face higher tariffs are steel (25 percent) and aluminum (10 percent), while China accounts for less than 1 percent of American steel imports.

It can be conceivable that the large bilateral trade imbalance won't be affected much even if the steel products from China are banned from entering the U.S. market. But it is noticed that the tariff-impacted industries, including high-speed rail equipment, new energy vehicles, and electronic communications, are the core industries that have been identified as a growth priority in China's development plan called "Made in China 2025." Levying a heavy tax on imports of goods related to the "Made in China 2025" plan might suggest the "true" underlying hopes of a trade dispute, that is, depressing China's future development of its high-end manufacturing industry, said Miaojie Yu, the vice president of national development research institute of Peking University.

Secondly, the fundamental theory of economics tells the Sino-U.S. bilateral trade imbalance is not a result of trade policy, but a result of the comparative advantages of each country's own factor endowment.

Generally speaking, China has a comparative advantage in labor-intensive goods, while the U.S. has a comparative advantage in the production of high-tech machinery. However, the top-ranked export products of China, such as electrical machinery and equipment, actually belong to processing trade. This means the capital-intensive components of China's labor-intensive manufacturing products are primarily imported from South Korea, Taiwan, and the U.S. So, the Trump administration's tariffs on imported final goods will directly affect its export of intermediate goods to China.

In this way, we can't tell whether the trade deficit is cut or not. Moreover, if the U.S. consumers' demand for daily necessities does not change in the short-term, then the consumers have to bear higher costs and pay more no matter what the U.S. continues to import from China (with harsh tariffs on imported goods) or produces from its own plants (with higher labor cost). Eventually, the US consumers will pay for the price for cutting any bilateral deficit with China.

So, how will China react to Trump's move?

The initial Chinese response may not be as severe as many fear. Going back to President Trump's threat to define China as a currency manipulator in 2017, China did make a big concession and agreed to increase imports from the U.S. in 10 categories. And even after the launch of the "301" investigation by the Trump administration, China still signed trade deals worth $250 billion with the U.S. during Trump's visit to China.

"What you're probably going to get from the Chinese is a low-key response to try to negotiate their way out of it," Robert Manning said, an expert on U.S.-China relations at the Atlantic Council in Washington. "I just worry if it gets really ugly, they may go for the nuclear option." A nuclear option, he explained, would be to sell a "couple hundred billion" in U.S. Treasuries, which would tank the markets and raise U.S. interest rates.

"China can take some measures to fight back, such as raising tariffs on imports of selected U.S. products" said Justin Yifu Lin, former World Bank Chief Economist. "Whereas the U.S. imports tens of thousands of Chinese products, China imports a narrow range of products from the U.S., such as soybeans, corn, computer chips, and aircraft. China's imposition of higher tariffs on imports from the U.S. would thus have a bigger impact on US producers than vice versa."

If a trade war hits the ground, China will reduce the greenfield investment and merger and acquisitions (M&As) in the U.S. The conservative estimate of job losses for that country is around 260,000, concluded Miaojie Yu, a professor at Peking University's China Center for Economic Research.

Very Different Effects on the Very Different Countries

In the short run, a trade war started by the U.S. would affect China's export industries. After all, exports to the U.S. accounts for around 13 percent of China's total exports. But the EU, ASEAN (Association of Southeast Asian Nations), and the other Belt and Road countries account for much more. So, in the long run, it's very likely that China can be immune from any Sino-U.S. trade war.

But for the U.S., it's a different story.

If the target is to reduce trade deficit and to protect domestic industries, then the tariff strategy will not work as expected, because abandoning free trade is usually linked to higher domestic prices and less job opportunities.